Three basic things to consider before applying for a home loan

By Gerv Tacadena
25 Jan 2019

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Buying a home is a complicated process — it is not like going to the mall and getting a piece of paper which signifies your ownership of a property. For many buyers in Australia, it takes weeks or even months to successfully complete a home purchase.

Applying for a home loan is one of the very first steps you have to take when purchasing a property. It is important for you to be knowledgeable about your finances and your options to ensure that the whole process goes without major hiccups along the way.

There are basic things Australians homebuyers need to know before applying for a home loan. To guide you in choosing the best home loan deal, ask yourself these questions:

Have you saved enough for a deposit?
Before even looking for a lender, you first have to be able to assess your current financial standing, your savings, and the security of your income stream. Checking your credit rating is also a must.

The next task on your to-do list is to make sure that you have enough money to pay 20% of your property's value. This is one of the toughest hurdles you need to overcome, especially if you are a first-home buyer.

Most lenders only allow homebuyers to borrow as much as 80% of their property value. Thus, you have to source the remaining 20% from your savings and from other means. This means that for a $500,000 home, you can only ask your lender to loan you $400,000 — the rest is all on you.

However, if you do not think you can meet the 20% deposit requirement, you can always ask your chosen lender if they will be able to let you borrow more. Some lenders are actually flexible enough to let you borrow as much as 95% of your home's value.

Here's the catch: if you plan to take out a loan exceeding your lender's limit, you will be required to pay lenders mortgage insurance (LMI). This type of insurance gives your lender protection in case you eventually are unable to fulfil your financial duties.

LMI is not something you have to take care of — it is typically the lender's job to arrange this, and all you have to do is pay a one-off premium up front when the home loan is granted to you. You can also have the LMI premium added to your loan, which will let you pay for it over a certain number of months.

The general rule of thumb regarding this is: the higher your deposit, the lower the LMI your lender will ask you to pay.

Which interest rate type — variable, fixed, or split — is suitable to your needs?
It is also important to consider which type of interest rate would fit your needs and current situation before applying for a home loan.

If you are the type of person who wants to take on risks for a higher chance of paying lower interest rates, then choosing the variable rate is the way to go. A variable-rate home loan has an interest rate that varies depending on the movement of the Australian economy or the monetary policy of the Reserve Bank of Australia (RBA). With a variable-rate home loan, how much you pay monthly is likely to change over the term of your loan.

Aside from having the chance to pay lower interest rates, a variable-rate home loan has several features that you can take advantage of, such as the ability to make extra repayments and the ease of switching loans.

The biggest downside, on the other hand, is that it will likely make your budgeting a headache, especially in times of increased rates.

For those who want everything planned, the fixed-rate home loan is the best option. A fixed-rate home loan is perfect for budget-conscious first-home buyers given that for a period of the life of the loan, the repayments stay the same. It makes budget planning easier and shields you from sudden interest-rate hikes.

However, the interest rate for this type of loan is usually fixed for only a period of time, usually one, three, or five years. At the end of the fixed-rate term, the interest rate switches to a standard variable rate.

Another downside of this type of loan is that over the course of your mortgage, your lender will usually limit extra repayments. You also may not avail of a redraw facility. If you change or settle your loan within the fixed-rate period, your lender may also charge you break fees. This is why it is not ideal to get a fixed-rate home loan if you are thinking of selling your home in the short term.

The last option is the split loan. It works by dividing your loan into two parts — one will have a fixed interest rate while the other gets a variable rate. There is usually no limit as to how you will divide your loan; it will all be up to you.

What home loan features will you need?
In order to be a wise borrower, you have to look beyond the interest rate offered by the lender. The rate is not the only feature that makes or breaks a great mortgage deal. Before applying for a home loan, you also have to look at several features that will make your transactions with your lender easier and more convenient.

One of the most useful features that you should look for is the ability to make extra repayments without additional costs. Making extra repayments will help you settle your loans faster and cut the overall interest charge. Having this feature will help you save thousands of dollars over the course of your loan.

If you are making extra repayments, then it would be beneficial if your loan also has a redraw facility. This feature allows you to use the advance payments you have made for other purposes, be it a home renovation, a car upgrade, or a major life event. However, a redraw facility is typically available only in variable-rate home loans.

Some of the other handy home-loan features are repayment holidays, top-ups, offset accounts, and line-of-credit facility.